I have been studying Austrian economics for about the past year. I accomplish this in the 3 hours per day I spend in my car commuting back and forth to work. I listen to books and lectures from some brilliant economists and libertarians. The reason I decided to write this post is because through this period of learning I have come across what I now know to be one of leading root cause of our economic problems in America, if not the root cause. That is the serious damage the Fed is doing to the citizens.
Ben Bernanke, the current Fed Chairman is known in the political world as a leading economist. I feel it important to discuss Bernanke because like his predecessor Alan Greenspan, he has a serious misunderstanding of market economy and its cause and effects. Bernanke has grown his reputation from being a head economic professor at Princeton and his doctoral thesis that was written on the great depression. He spent considerable time studying the great depression and is considered one of the foremost experts on the economics of that era. The problem with this is that Bernanke just has it all wrong. Sounds easy to say I know. I am right and he’s wrong. What I have learned is that when it comes to studying economics, you must ask the epistemological question of economics itself. This is something that the Main stream economists like Ben do not address and hence why they can deem themselves experts and really know little to nothing of the truth of economics. Before you decide who you will learn economics from and what it can teach you, you must ask the epistemological question of how do we know what we know about economics.
This is something that Keynes (Keynes general theory is what most main stream economics is based on) never addresses. Since economics is a social science, this is extremely important. This is what brought me to study the Austrian prospective. The father of Austrian economics, Ludwig Von Mises answers these questions in his book “The epistemological problems of economics”. He stated that economics can not be studied in the same way that natural sciences can. Since you can not perform verification or falsification in economics as you can in natural sciences, economics must deductive. It is A Priori Science. Meaning we must come up with its truths through contemplation and cannot through empirical evidence. Intention, purpose, means, ends, satisfaction and dissatisfaction are key terms when studying economics, yet how do you put precise measurement on them? How does one empirically prove ones satisfaction?. This is the main reason why Main stream and Keynesian economists refute it. Yet they never deal with the epistemological questions of how applying math and equations to economics actually works. Austrians do not believe in using equations (for the most part) in economics for this reason. What equation would you use to help define what “Purpose” a man or group has? Or would you suppose that understanding a mans “purpose” is not important when studying economics? I am here to tell you that purpose is extremely important if you want to study economics.
Ludwig Von Mises used Praxeology. That is the study of “Human Action”. It is not psychology, and it is important to understand the difference. Psychology is the study of mental processes and how it affects behavior. Praxeology is the study of human action outright.
Mr. Bernanke doesn’t even know the term praxeology let alone believe you must understand human action to understand economics. Mises states that economics is one part of Praxeology. Before you accept Bernanke as an authority over economics, just listen to him speak and ask yourself if your listening to someone using scientific method when it comes to economics. Here are some goodies from his public performances:
"House prices have risen by nearly 25 percent over the past two years. Although speculative activity has increased in some areas, at a national level these price increases largely reflect strong economic fundamentals."
"Housing markets are cooling a bit. Our expectation is that the decline in activity or the slowing in activity will be moderate, that house prices will probably continue to rise."
"The Federal Reserve is not currently forecasting a recession."
"The money supply is not changing in any significant way. What we’re doing is lowering interest rates by buying Treasury securities."
(Two months before Fannie Mae and Freddie Mac collapsed and were nationalized) "They will make it through the storm."
"We’ve been very, very clear that we will not allow inflation to rise above 2 percent."
(June 10, 2008) "The risk that the economy has entered a substantial downturn appears to have diminished over the past month or so."
"Not all information is beneficial."
(October 4, 2006) "If current trends continue, the typical U.S. worker will be considerably more productive several decades from now. Thus, one might argue that letting future generations bear the burden of population aging is appropriate, as they will likely be richer than we are even taking that burden into account."
This last quote is about as dumb as it comes. Lets all make our kids pay for us because after all,….they will be richer than us. In short, Mainstream economist have no frigging idea. When things are good, they always predict that things will stay good. If you look at the all recessions, the mainstreamers were saying it was the end of economic worry forever right up until it hits. Yet in 1928, one year before the great depression, Mises was warning about inflation and the boom and bust cycle coming to the end of its boom.
So back to my point. I apologize for the long preface to explain this point, but it is important. The number one reason for our economic down turn and most of them for the past 100 years is the Fed printing money. When the Fed prints money, they are literally stealing your money. Bernanke, Greespan and all the other chairman of the Fed have the power to do only one thing. That is print more money. That printed money does not come for free. It is directly proportional to the value being removed from circulation. (circulation means the physical money you and everyone else owns). So if there is a total of $100 in circulation and the Fed prints 10 new dollars, they have devalued your money by 10%. This is because they have printed money without any actual production of goods to back it. Printing money can and does have an effect of stimulation to the economy. One of the problems with stimulating the economy artificially this way is that it creates bubbles in particular industries which are almost impossible to predict. Many people blame the housing bubble on different things. Some blame the actual free market itself (which is beyond silly). Some blame the Community reinvestment Act of 1977 which was reinforced in the 1990’s. Some blame the Frank/Dodd and Dems from blocking regulation back in 2003 to regulate Fannie and Freddie. Quote from Frank in 2003
"The more people exaggerate a threat of safety and soundness [at Freddie Mac and Fannie Mae], the more people conjure up the possibility of serious financial losses to the Treasury which I do not see. I think we see entities that are fundamentally sound financially."
Although government was the reason the bubble was in the housing market and not some other market, but that is truly all irrelevant. If it was not the housing market, it would have been some industry. Why? Its because the money was there, and it should not have been. When the fed prints money, the end point where it gets into circulation is through the banks in the form of loans. The interest rate drops below its natural rate. The natural rate is where the amount of money available and the amount of people that want to borrow money balance each other to result in some interest rate charged by banks (it is the interest rate that makes the borrowers demand = the amount of money available to lend. If more people want to borrow than the bank has to loan the interest rate rises until peoples time preferences change enough that less people want to borrow. (at 5% interest perhaps 10 people want to borrow $100, at 10% interest, maybe only 6 of those 10 people are still interested). It also goes for the money side. If a bank has $100 to loan out they charge 10% interest and there will be exactly enough people that will borrow the full $100. If they have $200 to loan out, they will have to drop the interest rate to 7% to get more people interested. It is supply and demand plain and simple. The more money a bank has to loan out, the less the interest rate. The more demand there is to borrow the higher the interest rate.
So now lets say the Fed wants to print money and get it into circulation. The banks will now have more money to lend so the interest rate falls below whatever its previous natural rate was. This changes peoples time preference. A time preference is what entrepreneurs believe is the time it will take them to make a certain percentage of money. If someone has an idea for a business, lets say they want to build and sell houses. They think they can make 11% each year on their money by buying land and building a house and selling it. If the natural interest rate is 10%, most of these entrepreneurs may think it is too risky and hold off. 1% profit just isn’t enough for the risk and work involved. If the housing market goes up and they think they can make 13% maybe they jump in and start building houses. If the housing market slows and they can only make 10.5%, more entrepreneurs stay out. But if the Fed prints money and the interest rate drops to 5%, guess what? No one sees any risk and everyone jumps in to the housing market. Banks are not only lending to the entrepreneurs but also have so much money they need to lend that they are also lending to home buyers. Many of whom are not even qualified to buy, but what risk is there? If they fail to pay back, the bank will get the house and it will be worth even more than they originally loaned for it.
You can see the vicious cycle. Abnks lending mooney to buys of homes and to builders. They all have distorted time preferences due to artificially low interest rates. All of which is sparked by the Fed printing money and artificially lowering the interest rate below the markets natural rate. The result is an artificial bubble. Eventually the market saturates (no more buyers left) and you get the boom. This is the basic explanation of Von Mises’s “Boom and bust” cycle.
Meanwhile valuable resources have been pulled from other industries. People left their manufacturing jobs to become carpenters (because the demand was higher so the pay was higher). People left other industries to become real estate agents (why manage a restaurant when you can make so much money selling homes). So other industries suffer while the boom is in housing. Then the bust hits and not only do you have a dead industry, but a dead industry with too many people work in it that were supposed to be in other industries.
The good news is that according to Austrian theory, deflation comes with the depression. Deflation is when prices fall due to lack of demand. People are out of work and have no money so all industries prices fall drastically. Since prices fall, so do wages. Sounds bad right? Prices fall, wages fall, cant be good right? The good news comes from the fact the deflation actually starts the repair process because deflation also changes the entrepreneur’s time preference. There are entrepreneurs in all other industries that during the time of inflation and high prices could not make their idea work (regardless of interest rate). Now goods are cheap and wages are cheap. What better time to start a new business! Those who do have capital love to invest during a period of deflation. It’s when they get the biggest bang for their buck. So they start investing and creating new jobs for all those people in the housing bubble.
Now here is the bad news and I must bring Mr. Bernanke back into the picture. Mr. Bernanke doesn’t understand the Austrian business cycle. He has been taught his whole career from other Keynesian and Mainstream economists that deflation is bad. He must do anything to avoid it! So whenever he sees a sign of deflation what does he do? He starts up the printing press and gets inflation going again. So now he hasn’t let deflation do its good work of repairing the economy and he is already starting the next bubble with his printing press. Mainstreamers are very afraid of deflation. Austrians embrace deflation. What it comes down to is Austrians would do nothing. Let the deflation hit. Let the Entrepreneurs get their good deals while creating jobs and recession is gone. Bernanke thinks he cant let deflation hit. He is worried it is some black hole we cant get out of. Yes we will all make lower wages. But the price of goods falls as well and that money you saved up in the bank becomes more valuable and can buy more. You might just open that business you have always wanted and create a few jobs along the way.
I have more to say, but Austrian theory has a lot more to it than one post can hold.
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